Global Economics

Nokia: Rays of Hope Amid the Gloom

While the mobile handset giant posted an unexpected $834 million loss in the third quarter, its sales topped expectations

There's not much to cheer about in third-quarter results from mobile phone giant Nokia that included an unexpected net loss of €559 million ($834 million)—the first since the Finnish company started reporting quarterly results in 1996—and a nearly 20% decline in revenues year-over-year. That's €2.43 billion ($3.62 billion) less on the top line for the quarter. Investors were certainly in no mood to celebrate: By day's end in Helsinki trading, Nokia (NOK) shares were down nearly 11%, to €9.18, and they fell even more in New York.

But Nokia's bleak quarterly report issued Oct. 15 contained some important nuggets of hope. To start with, the company actually did somewhat better than many analysts had predicted. Overall revenues of €9.81 billion were slightly ahead of Wall Street consensus estimates, according to brokerage RBC Capital Markets (RY.TO). And tight cost controls allowed the world's largest mobile handset maker to turn in better-than-expected earnings before interest and taxes (EBIT) of €741 million, vs. consensus of €702 million.

As a result, Nokia's earnings per share, represented via non-IFRS (International Financial Reporting Standards) accounting, came in at €0.17, compared with an expectated €0.13. Operating cash flow was €720 million, or more than $1 billion, in the quarter. The €0.15 per share net loss under IFRS rules owed to restructuring charges, goodwill writedowns, amortization of intangible assets, and other impairments that added up to €1.167 billion.

Better-Than-Expected Handset Sales

The financial balancing act wasn't enough to satisfy some doubters. "Investors want to see more top-line performance and less performance through cutting operating costs," says Tavis McCourt, an analyst with investment bank Morgan Keegan, a unit of Regions Financial (RF).

But beyond the specifics of the quarter, Nokia saw several positive trends in underlying sales performance. Its quarterly volume of 108.5 million handsets topped expectations by nearly 3 million units, and its average selling price of €62 ($92.40) was slightly above analyst estimates of €61.20. Although Nokia's estimated global market share fell slightly to 37.6%, below some estimates, it was at the mid-range of expectations.

More broadly, Nokia predicted that the global handset market as a whole will shrink less this year than analysts had feared, down by 7% instead of earlier forecasts of 10%, and will grow sequentially in the fourth quarter. Coupled with the company's ability to hold the line on prices, this somewhat higher-than-predicted sales volume produced a 5% sequential rise in Nokia's handset revenues from the previous quarter, to €6.9 billion.

In a statement, Nokia Chief Executive Olli-Pekka Kallasvuo offered a modestly upbeat appraisal of the company's prospects. "The demand for mobile devices improved in many markets during Q3," he said, predicting higher handset volumes, flat market share, and improved operating margins for the company's devices and services unit in the fourth quarter.

That's the good news. The bad—very bad—news came primarily from Nokia's wireless infrastructure joint venture with Siemens (SI), called Nokia Siemens Networks (NSN).The unit, which has struggled amid lower capital spending by telcos and sharpened competition from Ericsson (ERIC), Alcatel-Lucent (ALU), and rising Chinese stars Huawei Technologies and ZTE, reported revenues of just €2.76 billion, down 13.7% from the previous quarter and a gruesome 21.2% from the year before.

Red Ink for Networks

All told, the unit posted an operating loss of €1.1 billion according to IFRS rules, which take into account all the writedowns charged against it. Analyst T. Michael Walkley of investment bank Piper Jaffray (PJC) notes that the third quarter is seasonally soft for network equipment sellers but lays much of the blame on aggressive price competition from Huawei and ZTE.

CEO Kallasvuo promised that Nokia will "continue to support Nokia Siemens Network's actions to improve its performance." But he couldn't offer much optimism. Although he now predicts that the wireless network equipment sector as a whole will shrink by only 5% in 2009, vs. an earlier estimate of 10%, he also cautions that NSN will lose more market share this year than expected.

Another trouble spot for Nokia is in so-called smartphones, which have more computing power than typical handsets and can run software programs downloaded over the air. Rivals such as Apple (AAPL) and BlackBerry-maker Research In Motion (RIMM) have stolen Nokia's limelight in this growing and profitable category. Although Nokia still outsells them both, it's losing momentum and market share. Sales of its high-end Nseries and Eseries devices fell in the third quarter, to 16.4 million units, down from 16.9 million the quarter before. That gave it an estimated market share of around 35%, vs. 41% in the second quarter.

It's worth noting that this is the first time in Nokia's history that its share in smartphones was lower than its overall handset market share; only a few years ago, its smartphones accounted for half of the market. Analysts and investors worry that the Finnish giant may never return to those glory days. "The only focus for investors now is the smartphone market-share slide," says analyst Tero Kuittinen with equity research house MKM Partners. He notes that early announcements of several new Nokia models shipping this month may have suppressed third-quarter sales. "If demand for those models is good, the fourth quarter could be solid," Kuittinen says.

While its results were mediocre, Nokia has bounced back from far worse crises. The company still enjoys unparalleled brand equity, distribution, and manufacturing prowess. If handset demand rises in the fourth quarter, Nokia could see a big jump in results for its devices and services unit because of its enormous leverage. But as long as Nokia Siemens Networks keeps bleeding, bottom-line results will continue to look ugly.